Market Brief: Currency Volatility Continues to Fall

CalendarFebruary 26, 2024

Good morning. With a barrage of economic data releases and central bank speeches scheduled in the days ahead, traders remain unwilling to take big directional positions. Treasury yields are little changed, equity futures are setting up for a flat open, oil prices are down slightly, and the dollar is holding last week’s gains.

Volatility in the currency markets continues to drift lower, and it’s admittedly difficult to see what might break this dynamic.

3-month at-the-money implied option volatility

We count at least fourteen appearances from Fed policymakers on the schedule this week, but most are likely to follow in Governor Christopher Waller’s rhetorical footsteps. In a speech given last Thursday, he said January’s “high reading on consumer price index inflation may just be a bump in the road, but it also may be a warning that the considerable progress on inflation over the past year may be stalling”. He said this “has reinforced my view that we need to verify that the progress on inflation we saw in the last half of 2023 will continue and this means there is no rush to begin cutting interest rates to normalize monetary policy," suggesting that “at least another couple more months” of data would be needed to put the conditions in place for rate cuts.

Markets seem well prepared for an acceleration in price growth when January’s personal consumption expenditures number drops on Thursday. After this year’s dramatic pivot, investors and Federal Reserve officials are the most closely aligned in months. Just three rate cuts are now priced into the forward curve, matching the median forecast embedded in the central bank’s last “dot plot” summary of economic projections, and limiting the likelihood of a violent reaction to a hotter-than-anticipated report.

Inflation prints in Japan and the euro area seem unlikely to deliver significant upside surprises, with domestic demand conditions in both economies looking far from overheated, while exogenous shipping and energy prices remain well-contained .

But foreign exchange markets do have a tendency to defy forecasts and deliver nasty surprises when they’re least expected. A slew of risks, from an imminent government shutdown to signs of weakness in US labour markets, could collapse the current consensus and trigger unexpected moves. As Warren Buffett put it in Berkshire Hathaway’s annual letter, published Saturday, “Neither Greg (Abel), nor I believe we can forecast market prices of major currencies. We also don’t believe we can hire anyone with this ability”.

My career plans have thusly been derailed, but yours needn’t be. If past is prologue, hedging your organization’s exposures while markets are at their most placid can prove enormously useful in staying afloat. To quote Buffett again (in a shameless attempt to get him to hire me), “Predicting rain doesn't count, building arks does”.


Karl Schamotta

Karl Schamotta

Chief Market Strategist

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